Hercules Capital, Inc. (NYSE:HTGC) reported second quarter results last week that continue to support the bullish thesis with respect to valuation, yield, distribution coverage, portfolio quality and risk/reward. Hercules Capital outearned its (raised) quarterly distribution with both net investment income and distributable net operating income. The company also declared a special dividend again. Shares remain attractively valued and have a compelling risk/reward. An investment in HTGC yields almost 10 percent.
Hercules Capital is a business development company with a focus on "pre-IPO and M&A, innovative high-growth venture capital-backed companies and established stages in a broadly diversified variety of technology, life sciences and sustainable and renewable technology industries". The company is structured as a BDC, meaning it is regulated by the Investment Company Act of 1940.
Hercules Capital largely invests in senior secured first liens which represented about three quarters of the BDC's investment portfolio at the end of the June quarter.
Here's a portfolio snapshot.
Hercules Capital's debt investment portfolio is currently valued at $2.08 billion and includes 99 different portfolio companies. The BDC also invests in equity and warrants in order to profit from successful portfolio exits and capture a larger share of the upside tied to those investments. Equity returns, however, are notoriously unpredictable, but also have the potential to boost the company's overall earnings.
Hercules Capital's investment business is currently on fire. The company has seen multiple net investment income records in the last several years due to strong financing demand from young, innovative tech companies: HTGC's net investment income hit a record of $35.3 million in the second quarter, which marked an increase of 54.9 percent year over year.
Hercules Capital is on track to reach new net investment income records in 2019 if the company can sustain its momentum throughout the latter half of the year.
Source: Hercules Capital
Hercules Capital has exceptional portfolio quality.
At the end of the June quarter, Hercules Capital's non-accrual ratio, which essentially measures the BDC's non-performing loans, represented just 0.2 percent of all investments, based on fair value, which is extremely low. A company places a loan on non-accrual when it has reasons to believe that the payment of interest and the repayment of its principal are in doubt. Hercules Capital's accrual trend is very strong, and the portfolio is almost fully performing.
Source: Hercules Capital
Another indicator that the company's portfolio is in good shape relates to its debt yields. Hercules Capital's core portfolio yield was 12.7 percent at the end of the June quarter, unchanged from the previous quarter. Stable portfolio yields indicate strong market conditions and a fully performing debt investment portfolio.
Source: Hercules Capital
Hercules Capital outearned its quarterly dividend of $0.32/share with net investment income and distributable net operating income in the last twelve quarters, on average: $0.32/share in NII and $0.34/share in DNOI compare against an average dividend rate of $0.31/share. HTGC raised its dividend to $0.32/share in the first quarter of 2019 and also declared a $0.02/share special dividend for the second quarter in order to distribute excess income.
Here's are HTGC's dividend stats, updated for Q2-2019.
Hercules Capital's 9.9 percent dividend costs income investors ~9.0x Q2-2019 run rate net investment income, which is still a sensible NII-multiple. Shares also change hands for a 22 percent premium to the last reported net asset value of $10.59/share.
Hercules Capital's shares have been priced at a premium to NAV for a long time, which is a reflection of the BDC's excellent financial performance, strong NII growth, and excellent credit quality.
Hercules Capital, contrary to many other BDCs, still offers an attractive risk/reward ratio, in my opinion, largely because the company has impressive portfolio quality, has historically had low non-accruals, and strong portfolio and NII growth due to high demand for venture capital, both equity and debt.
Going forward, investors nonetheless need to carefully watch the company's non-accrual ratio: Any deterioration in Hercules Capital's portfolio quality is a red flag as far as the distribution is concerned.
Hercules Capital also has a large floating-rate asset base - 97.7 percent of its portfolio is variable rate - which is something I generally see as a weakness in light of the most recent interest rate cut. However, Hercules Capital's management has been a good steward for shareholders in the past, and the company has a large, diversified investment portfolio with a strong first lien focus, which, I think, will limit the fallout from potential economic trouble down the road.
Hercules Capital covered its dividend with NII and DNOI in the second quarter and once again distributed excess earnings as supplemental dividends. Hercules Capital's portfolio quality remained superb as well, and the company sells for a reasonable 9.0x Q2-2019 run-rate NII-multiple while exhibiting an almost 10 percent dividend yield. HTGC is a "Buy" with respect to valuation, yield, dividend coverage, credit quality, and risk/reward.
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Disclosure: I am/we are long HTGC. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.